Bases and Methods of Valuation for Plant & Machinery
The basis of valuation for a machinery valuation could be Market Value, Equitable Value or Fair Value. Each of these three bases has its own definition.
The basis of valuation is determined by the purpose of valuation, for example if the purpose of the exercise is to ascertain an expected selling / asking price on the open market, then Market Value is the appropriate basis. However, if a closed (private treaty) transaction is envisaged involving a sale to an identified purchaser and one wants to determine the fair price to be paid, then potentially Equitable Value would be appropriate.
If the valuation is for Financial Statement purposes, e.g. to determine the balance sheet value of some assets, then the Accounting Standards (IFRS and UK GAAP) dictate that the basis of valuation should be Fair Value.
The definitions are as follows:
Market Value: The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgably, prudently and without compulsion.
Equitable Value: The estimated price for the transfer of an asset or liability between identified knowledgeable and willing parties that reflects the respective interests of those parties.
Fair Value: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market (sector) participants at the measurement date.
Fundamental assumptions must then be adopted under each basis, the most common being in respect of Market Value or Equitable Value, i.e. whether the machinery is to be valued as a whole in-situ, for use in its working place (i.e. as a ‘turn key operation’) or valued for removal from the premises at the expense of the purchaser (‘ex-situ value’).
(n.b. one other ‘Basis of valuation’ would be ‘Insurance Valuation’ which considers the reinstatement (replacement) cost of the assets in the event of a loss (either reinstated as new (‘new for old’), or replacement with second hand assets of the same age (‘indemnity’), however, some would say this is an assessment rather than a valuation per se).
The method of valuation, on the other hand, is determined by the approach the valuer uses to reach his or her opinion on whatever basis they have adopted. All valuations adopt either a market approach, a cost approach or an income approach (or a combination of these approaches).
So when we receive an instruction, the first thing to be determined is what is to be valued (i.e. the subject matter and the interest) and who the client is. Then we need to know the purpose of valuation, so that we can advise as to correct basis of valuation (we also need to know where the assets are located and when they need to be valued, i.e. the date of valuation). I call the ascertaining of this information at the outset the ‘who, what, why, where and when’ rule. Once these facts are established, we can determine the most appropriate method of valuation, for example:
1) The comparison method (i.e. analysing historical market transactions) which is a ‘market approach’;
2) The Depreciated Replacement Cost (DRC) method (i.e. depreciating the new replacement price / cost of the machine by estimating its age, economic life and residual value, in order to opine on its current value) which is a ‘cost approach’, or;
3) A combination of the above two approaches (which is often my favoured approach), i.e. a DRC framed with reference to market evidence.
Plant & Machinery valuations generally adopt one of these methods, however, the comparison method can also be stretched to include speaking with dealers for anecdotal market evidence / opinions and considering asking prices for similar assets.
Income approaches can sometimes be adopted for machines which have an income stream directly attributable to them, but this is rare in my experience. The income approach is much more commonly used to value intangible assets / goodwill.
Finally, the basis and method of valuation should, if appropriate, also have reference to the best method of sale envisaged. For example, if we are considering a sale by auction to be the best way of maximising the realisation, then Market Value ex-situ assuming a sale as individual items is appropriate (and the prime method of valuation would be to seek auction sale comparables). If however, a sale of all the machines by private treaty for removal is considered a better option, then Market Value ex-situ assuming a sale of the assets as a whole is more appropriate, and all comparable market evidence would be sought and considered.”
|Purpose of Valuation||Possible Basis of Valuation|
|Valuation of assets to be sold on the open market for removal from their current location||Market Value ex-situ|
|Valuation of assets to be sold on the open market for use in their current working place||Market Value in-situ|
|Valuation of assets to be included on a company’s Asset register / Balance sheet / Financial statement||Fair Value|
|Valuation of assets for collateral purposes (e.g. as loan security)||Market Value ex-situ|
|Valuation of assets to be sold on the open market as part of an ongoing business||Market Value in-situ / Fair Value|
|Valuation of assets to be sold to an identified purchaser, e.g. a connected party||Equitable Value|
By Thomas Allman MRICS